HSBC: RBA on hold in July, may cut later in 2013

HSBC and Westpac are in agreement that the Reserve Bank of Australia will keep rates on hold next week and both credit the Australian dollar for taking the pressure off.

After all, the $A has fallen 11 per cent on a trade-weighted basis in the space of two months, earning the descriptor “shock absorber" from economist Paul Bloxham. (He notes that at these levels the currency poses “a modest upside risk to inflation".) As a rule, a 10 per cent depreciation could add about 0.3 percentage points to 0.4 percentage points to the consumer price index each year, “which all else equal, would lift the RBA’s inflation forecasts to around the middle of the target band by end-2013".

Even so, inflation should still be low enough to warrant a rate cut in August.

Tapering and China have a role to play in the RBA’s decision making, too, with China adding to weak conditions that coincided with Australia’s soft gross domestic product reading and evidence of the US recovery supporting a greenback rally and $A selling.

But what happens to interest rates if the $A keeps falling to, say, US85¢? Remember the minutes of the June meeting showed the RBA thought the Aussie was still overvalued. That could wipe out the case for further rate cuts for the time being.

The significance of the $A fall is that it has come at a critical time for the economy as we try to adjust from mining investment to something else, whatever the next great investment wave may be.